The Paradox Of Merkelism And ING's Not-So Grand Bargain

Despite another weekend of hope-driven chatter of a support-the-profligacy, print-til-we-die, mutually assured destruction game of chicken, we remain as far from the fiscal federalism, that we discussed earlier in the week (and the four critical questions that need to be answered) as ever. As we embark on yet another critical week in Europe's (and perhaps the world's future), ING addressed a critical aspect of the conundrum - that of Merkel's (read Germany's) reluctance to step on the gas and save the known universe. While attempting to quantify the price of break-up and the pay-now or pay-later perspective, they describe perfectly the 'Paradox of Merkelism' in that the core countries' attempts to limit their exposure have served only to increase it. They further worry that while a plan for a Grand Bargain may appear, this may rapidly give way to the recognition that the reality is not so grand - the bargain would still have to be delivered.

ING: Break Up. Pay Now Or Pay Later

The Paradox Of Merkelism - Risky Caution

Amid the rising sense of panic in the financial markets, there is frustration at the hesitant response of policy-makers in the core countries, led by Germany. Although German Chancellor Angela Merkel continues to proclaim “if the euro fails, then Europe fails”, she remains reluctant to sanction the dramatic fiscal and monetary measures that many see as essential to prevent EMU fracturing. The general perception of the financial markets has been that Eurozone policymakers’ actions have been “too little, too late”.

The key to this has been the reluctance of Germany and the core countries to commit more resources. In part, this reflects the political challenge of persuading their electorates of the need to support their peripheral brethren, who are widely portrayed as having brought their debt problems upon themselves.

However, Merkelism is not just about the awkward politics of burden-sharing. It also reflects deep-seated German convictions about the economics of the sovereign debt crisis. It is viewed as largely a result of fiscal ill-discipline on the part of the peripheral economies. The Germanic prescription is therefore fiscal restraint. Coupled with this is Germany’s long-standing antipathy towards inflation, rooted in its past episodes of hyperinflation. As a result, Germany and its core partners have consistently chosen the most austere policy options:

1) reluctance to increase the bail-out packages for Greece and the other peripherals. This culminated in the agreement to try to extend the firepower of the European Financial Stability Fund (EFSF) not with bigger commitments from the member governments but with additional borrowing.

2) an insistence on tough fiscal austerity measures in the peripheral economies. The notion that this ought to be offset by fiscal relaxation in the core countries is rejected.

3) a resistance to the notion of the becoming a ‘transfer union’, in which tax revenues flow from the richer core to the poorer periphery.

4) a rejection of the idea of a common Eurozone government bond, which would entail members becoming liable for each other’s debts.

5) insistence on private sector involvement (PSI) in the restructuring of Greek public debt. The proposal that private holdings should be written down by 50% (while leaving official holdings unimpaired) damaged investors’ perceptions of all Eurozone sovereign debt.

6) objection to sanction the European Central Bank (ECB) acting as ‘lender of last resort’ to Eurozone governments. The fear is that such ‘debt monetisation’ would both create moral hazard by weakening the incentives for governments taking the necessary actions to reduce their debts and pose long-term inflation risks. The Bundesbank, supporting this position, has argued that the ECB’s securities market programme (SMP) to buy peripheral government debt should be limited and temporary.

7) support for the ECB sticking to its anti-inflation mandate, which was manifest in its support for its decision to raise its refinancing rate from 1.0% to 1.5% earlier this year. With headline inflation remaining embarrassingly high at 3% the ECB only grudgingly agreed to cut interest rates to 1.25% at its meeting on 3 November, despite manifest signs of a sharp slowdown in economic growth.

With the core creditors in the driving seat, the net effect of this has been a powerfully contractionary fiscal and monetary stance across that has pushed the Eurozone into the deleveraging doom loop pictured above (Fig 4). Far from instilling confidence, fiscal austerity has led to a downturn in growth, now in the core as well as the periphery, raising further doubts about fiscal solvency and so driving up bond yields further.

This is not to say that German policy-makers are unaware of the need for economic growth. Aside from the so far abortive attempts to restore confidence through fiscal austerity, they point to the need for supply-side and governance reforms. On this score, there is near-universal agreement. The failure of peripheral economies both to liberalise their labour and product markets and to tackle government inefficiency and corruption has certainly weighed on their competitiveness and performance.

But, as Angela Merkel herself is prone to say, supply-side reforms are not a quick fix. Implementation is politically challenging, and the benefits take years to come through. Unfortunately, with austerity biting harder and faster than reform, the financial markets are not prepared to wait for years.

So the paradox of Merkelism is that the core countries’ attempts to limit their exposure have served to increase it. A cautious step-by-step approach to fiscal integration designed to put the euro on a surer footing has so far served to undermine it. With the peripherals increasingly confronted with the prospect of long term austerity, exiting EMU becomes correspondingly more appealing.

And yet the media, and every hopeful long-only manager in the world, is talking up the 'Grand Bargain' that is about to be struck this week to save the Euro. ECB to provide more support, a super-sized EFSF, a common Euro-bond, all in return for tougher (and potentially enforceable) fiscal rules. Of course, all 17 nations will jump at the chance and ratify instantly...while many assume this is the holy grail-like case, we suspect any relief will be short-lived since not only will the process likely be too long-winded (and leave too much uncertainty for an increasingly risk-averse and career-risk-anxious buy-side), fiscal solvency will take years to restore and is for surer a recipe for slow, stagnating growth (at best).

Euro movements are insignificant details in the overall scheme of things of financial engineering failure.

The end is near. No one wants to be the first to default.

TPTB are holding the first domino but there are only a few threads left holding it. The moment a Greek or an Italian politician who insists on austerity is attacked or killed, the last threads will break.

as if somehow it did. greek sovereign debt is pressing 300% yield. past a year it trades at 25 cents on the dollar. a proposal for a fifty percent haircut has been overtaken by events. if the ecb/imf/fed solved all the problems of italy, spain and france (and they won't) most european banks would still be insolvent from associated exposure to greek debt alone.

fiscal austerity in a global deflationary depression will not fly in any vaguely democratic political process. that it is being pressed by germans in a europe ravaged by two great wars seen as started by germans and in the u.s. by an utterly corrupt and impractical crony fascism does not help.

You may be right about the fundamentals, but that's not the way the central banks are working it. Benny is lending dollars to European banks (who issued scads of dollar-denominated bonds). If he didn't, those banks would have to buy dollars for euros to pay those bonds, thus pushing up the former and weakening the latter.

The problem is that everyone wants to devalue relative to everyone else, all at the same time. Gold provides the only fixed point of reference.

This is the least complicated 'conundrum' I've ever witnessed, relative to the commotion made of it by the Main Lame Ass Stream Media & all the talking bobble head alleged experts, policy wonks & academicians (including Nobel Laureates) in all of my years on earth.

There are two choices in the bid to either prop up or not prop up prolific sovereign spenders (with governments captured by fractional reserve central banks and their masters [other banks & the MIC]) to the fundamental hazard of the citizenry of said sovereigns:

1) Print sequentially larger and larger batches of digital and paper/coin fiat, leading to higher and higher inflation, killing more and more of whatever is left of the genuinely private, organic economy and non-governmental consumption (fueled by deficit spending), in order to recapitalize the galactically massive black holes that are alleged (ALLEGED by CNBS and Bloomturd and captured CONgressman and Regulators) too-big-to-fail banks that have been run by criminally incompetent (or just criminal) thieves, which will lead to massive social/political/economic disturbances;

2) Purge the debt that's mainly based on illusory, fractional reserve banking fiat, conjured from thin air, and let the forest fire that should have raged years ago rage now, burning down the dead wood that is much of the banking/financial sector, which will only fuel larger and far more hazardous fires in the future, and in doing so, get closer to the point of reestablishing a firm foundation of truly organic economic meritocracy where knowledge, efficiency, competency, hard work and free market capitalistic virtues (truly advancing human society) are rewards, and Crony Capitalist Kleptocracy (aka Deep Capture) is ridden out of town and beaten dead into the dust and ashbin of history.

This is truly the time to opt out of the Global Ponzi, which emanated from Manhattan & London, and spread like wildfire to almost every corner of the earth. If you think you can win the game rigged so badly in favor of the criminals running the house more often than not, or win over anything remotely resembling a long time horizon, you're deluding yourself.

Invest in yourself. Become self-sufficient. Learn essential skills that will always be in demand. Build up your trusted networks of family & friends. Acquire real wealth. Divest yourself of toilet paper posing as money.

Option 2 however, will be upon the banks in either case sooner or later. War will be the defence mechanism reaction to have us trying to survive rather than think revolution. But I believe this time, we will not fall for the boogie man.

Hilsenrath, literal mouthpiece for Bernanke, wrote an article in the WSJ today about how the Federal Reserve Den of Vipers & Thieves is now planning a public relations full frontal assault in an attempt to apparently try and delude people into thinking they have the average Joe and Jane Main Street's interests at heart, rather than the bestest friends of the New York Branch of The Federal Reserve.

What was that thing Goebbels said about the necessity of repetition when it came to successfully spreading propaganda and lies?

Kill the Federal Reserve Bank and any successor to it (before it's even hatched) by whatever official and even patriotic or semi-patriotic name it deceptively goes by, and don't ever let it slither back into existence, whether 10 years or 100 years from now.

I think what it comes down to is that given a choice between being right or being happy, the Germans choose being right. They don't really care just how unhappy being right is going to leave them ... as long as they are still right.

The time will come when Germans will need to decide either to leave the Euro or to gurantee the ClubMed debts/liabilites. But since the Germans are the largest benefactor of the current Euro, I guess it's only fair :)

This article is riddled with fact-based realism, a direct contrast with Bloomberg's every other guest analyst who praised this week's all-but-sure but yet-to-come resolution, that will make the Christmas really even more "insane".

It's like having two parents trying to explain something to you, one of whom is an alcoholic crackhead with psychotic tendencies hooked on acid 24 hours a day dressed as a hot dog.

P.S. Market says the global economy is fixed now that Italy has passed its austerity measures.

The reference is always to 1923 Hyperinflation caused by Franco-Belgian invasion and Occupation of the Ruhr. The inflation was brought under control by Hjalmar Schacht of the Reichsbank in 1925, and he had a mutually supportive relationship with Montagu Norman of the Bank of England. What Germans learned was that they had lost Sovereignty in 1919 at Versailles, were subject to French whims and had huge Reparations to pay for which they had to borrow capital from London and New York.

They lost Sovereignty in 1945 and never really regained it in 1990 as it was subsumed in the European Union treaties. Having lost savings in the Currency Reform of 1949; and in the inflationary exchange rate deal brokered by Kohl in 1990 to buy Ossi votes; Germans have spent 21 years saddled with levies and stealth taxes to pay for Unification, most of them loaded onto Social Security charges. So West German workers were priced out of jobs through Social Costs used to subsidise East Germany and watched businesses move to Asia and eastern Europe for lower wage costs. Added to which Green Policies imposed through the EU and the loss of cheap holiday resorts in Southern Europe as the Euro gave them private sector credit lines to speculate on property boosted through capital flight of tax haven bank accounts being emptied of legacy European currencies prior to the Euro in 1999.

Germans know they are being stiffed. They know the Banking Blowout was US/UK answer to stagnating economies and failed manufacturing sectors; they know that Anglo-Saxons went overboard on low-taxes and lots of Magic Money to pay for grand projects - after all it is how the US funded The Great Society and Vietnam without burdensome taxation - it simply taxed the world through Bretton Woods until 1971 collapsed that scam.

Germans feel they are always put on the wrong side of history no matter what they do; that France thinks every other nation is subservient to its Gloire, and that the US/UK Banking Sector is a Black Hole and a Vortex where Matter gets destroyed by Anti-Matter

Would take issue with the failed manufacturing sector hypothesis. It needs to be mentioned that the Germans as well as the Japanese have never evolved into a consumer based society. They have been stuck in the Begger thy Neighboor export model since WWII. This is the core problem with the EU. The internal exchange rate has blown up the EU periphery. If you want to talk about the loss of the manufacturing base, take a look at Northern Italy.

BUt back to the story. The US in turn bore the brunt of the globalization impact (the devastation of its manufacturing sector) when Communist China, India and South American entered the globalization process. This led to the Germans and Japanese to increase the subsidization of their export sectors. This in turn caused the US to be the market of last resort for the global economy.

So if anybody is the victim in this economic morality play, it is the US and the US consumer who is bearing the brunt of the global imbalances.

Yes, a Begger thy Neighbor export model of the Germans is the root cause of the Euro currency problem.

This is why the Eurocrats, read Germans are willing to throw Club Med into a debt deflation spiral. They are terrified that if the Germans left the EURO, and the Euro revalued to relect the economic situation in the Club Med, it would blow up their export sector. 75% of all German exports end up within the EU:)

Sorry to crush a good narrative, but I find it hilarious that Geithner and Biden are in Euroland this week to strongarm the Germans into allowing the ECB to reflate the EU/Club Med economies. At the behest of the ClubMed states/IMF, I might add. Too funny, you must admit? :)

It needs to be mentioned that the Germans as well as the Japanese have never evolved into a consumer based society.

You must have been in the GDR. West Germany was a consumer society, or at least homes were filled with consumer goods and SONY had a huge business with the largest overseas sales company after the USA and equal in size to France and UK combined. I cannot believe you have walked down Hohe Strase in Cologne or been around Saturn or Media Markt or ever visited any of the shopping malls that litter the landscape. Compared to German consumer offerings at retail level Britain is a backward down-at-heel peasant kingdom. If your definition is based on Wal-Mart and MBNA then you can claim the US is a consumer paradise on borrowed money, but you clearly have little knowledge of the German consumer debt problem, the level of evictions from rented apartments, and the repossessions taking place.

Her plan clings to the Wagnerian myth that Club Med fiscal extravagance is the cause of all the trouble, though Spain had a budget surplus of 2pc of GDP five years ago and never broke the Stability Pact - unlike Germany - and Italy has long had a primary surplus ...

Germany is unwittingly doing to Spain exactly what America did to Weimar Germany after flooding the country with cheap capital in the late 1920s. When Wall Street cut off funds and ended the credit boom, Germany collapsed ...

There was a chorus of self-righteous pedants in Hooverite America who turned this into a question of cultural ethics, reproaching the Germans for lack of discipline and failing to work hard enough. Sound familiar? ...

... we may just have to hunker down yet again and wait for Germany to blink at last, or detonate the fuse. »

Pritchard is an intellectual twat, and he literally and essentially believes that printing more fiat at this point in history is the cure for what ails the (overwhelming) majority of already steeped & saturated in massive debt (unpayable except via the process of something approximating super-inflation, i.e. above 10% per annum for decades), developed nations,

In other words, Pritchard is preaching the nonsense of digging oneself out of a hole, either because a) he's genuinely malevolent, and is willing to use his journalist's card to try and sell putting lipstick on the pig of destroying a citizenry's standard of living in the name of bailing out massively indebted (to private central banksters) sovereigns, or b) Pritchard went 'full retard' and actually believes that taking on crushingly large desposits of new debt, whether to expand the pig that is the government sector, pay for inefficient and wasteful government-prompted porkopulis 'stimulus' projects, and/or nationalize and zombify banks so bloated and inefficient that they are literaly parasites on all things productive (shrinking by the day, as more and more hosts die), is a brilliant idea that can ultimately cure the disease, although it's akin to not only not putting a band-aid on a sucking chest wound, but is closer to sticking a sharpened flag pole into the wounded individuals heart and lungs while they're in their waning moments.

Pritchard either willfully ignores or doesn't 'get' that the disease, itself, is debt, and that adding more of the disease to the prescribed remedy can only hasten death.

Of course austerity will lead to a great deal of pain. But only the bitter but efficacious medicine that is austerity has any prospect of purging the disease from the system and allow for real, organic growth again one day.

Pritchard wants to give the heroin addicts in withdrawal higher and higher doses of methadone, apparently indefinitely, which is just another substitute for the heroin itself, with many of the same adverse side effects, rather than tie the addict up and get them to vomit, shit themselves, and perspire profusely for several days, in order to purge their system of the very drug that is creating their cravings and disease.

As to AEP, the problem he is addressing by calling for ECB easing is as follows:

While real M1 deposits are still holding up in the German bloc, the rate of fall over the last six months (annualised) has been 20.7pc in Greece, 16.3pc in Portugal, 11.8pc in Ireland, and 8.1pc in Spain, and 6.7pc in Italy. The pace of decline in Italy has been accelerating, partly due to capital flight. "This rate of contraction is greater than in early 2008 and implies an even deeper recession, both for Italy and the whole periphery," said Mr Ward.

The only way to get the money aggregates to stop crashing, and give the EZ a chance to at least "right its ship" is for massive ECB intervention. They are the only ones who can do it.

As to the resolution of the Euro Problem, AEP advocate the break up of the Euro zone into the Gremanic camp and Club Med. This would allow the periphery countries to regain their competitiveness, which they can not presently because they are stuck in a currency union that doesn't allow them to reflate their economies. (I.e. cant devalue the Euro, now can you.)

And for whatever it's worth, this is the only rational and sensible solution to the Euro crisis other than a full political/debt/transfer union. Or in other words, a United States of Europe.

Pritchard is histrionic and wrong. Where was he when the current Prime Minister of Greece was Central Bank Governor pledging Airport Fees to Goldman Sachs in payment for fiddling the books so Greece could join the Euro when Schroeder and Fischer were fiddling the Stability & Growth Pact with the French because NEITHER could meet it ?

Pritchard is histrionic and wrong. Where was he when the current Prime Minister of Greece was Central Bank Governor pledging Airport Fees to Goldman Sachs in payment for fiddling the books so Greece could join the Euro when Schroeder and Fischer were fiddling the Stability & Growth Pact with the French because NEITHER could meet it ?

The cheap capital exports were an automatic result orf the currency union, which was a French idea.

"Germany" (meaning her people) never wanted to a/ introduce the Euro, b/ bail out anyone, c/ tell other countries how to fix their budgets.

Germany was forecd into this and Merkel does not have the courage or will to get Germany out of this. (What would our "friends" say??) Germany can only lose. And make no mistake: Germany is the victim.

Germany can pay and print and demand nothing. Germans will lose out big time. Good luck, German democracy...

Totally agree with you Otto. The problem is actually the loses incurred by the Germans if they leave the EZ. If the Germans left the Euro, the DEM would revalue to somewhere in the neighborhood of minus 15 to minus 10 big figures to the USD/CHF. By the same token, the Rump Euro would crash back to .85 EUR/USD. You can imagine what that would do to the German export sector. Worse yet, it would force the German banking sector to Mark to Market it's debt, thereby making the German sector ( read DB) insolvant. Next, the balance of payments issue within the START2. Buba has been financing the German trade surplus through the European internal payments system to the tune of 450b Euro. This alone would bankrupt the other EU states if Germany called in their funds. So Germany woun't, which means it would be passed on to the German taxpayer. Next the Buba/German capital in the ECB, which would become insolvant overnight. 6.2bEURO of capital with 70bEuro losses on MtM of existing sovereign debt that it is holding. And the list goes on, and on, and on......

In other words, you are 100% correct. The Germans have nothing to be happy about. And you only have yourselves and the French to blame.

It might do more harm to Allianz and Deutsche Bank since they carry risk on their books. Manufacturers have diversified with Continental tyres in Romania; Porsche Cayenne/VW Tuareg from Slovakia; and BMW sourcing X5s and Z cars from its US factories. There are so many German "exporters" that are exporting from overseas factories - like Bosch for example - that it is more a case of "German Made2 than "Made in Germany". It is not only Americans that can built multinational businesses.

Germany's key factor for the future is raw materials and for that Russia is its most important market just as before 1914 when Siemens was huge in Russia. Germany could manage an appreciating D-Mark because the cost-of-living would fall for German Voters and the strength of the currency would match the demographic profile far better than it does in Italy.

The French wanted to control the Bundesbank and forced Kohl to accept the Euro in return for Unification. German industry liked the idea of a Single Market and unlike the British actually had something other than Banking and Property Development to service that Market. But Germany does not need to implode to keep Spaniards and Greeks in US-built or South African built BMWs